At least there’s hope of lasting recovery

During the economy’s bleak years — broadly from when he took office until early this summer — Chancellor George Osborne has blamed the eurozone for our troubles. The reason things were not working out as he had said they would — why exports failed to rise and borrowing failed to fall — was because the eurozone, our major trading partner, was stagnating.

Today, the economy is doing much better and the forecasts for next year, unveiled with a flourish this morning in Osborne’s Autumn Statement, imply that there is much more good news to come. But please note this recovery comes not because the Chancellor has changed his policies. Indeed, he makes a virtue of not having done so, although this claim does rather modestly ignore his efforts to stimulate the housing market and provide guarantees to companies willing to invest in infrastructure.

Nevertheless, the other big thing working in the UK’s favour, as much as it was an earlier drag, is the better economic performance of mainland Europe — a recovery that sparked to life earlier this year after European Central Bank president Mario Draghi finally got the markets off his back by making it totally clear he would do “whatever it takes” to see the eurozone through its troubles.

So an Italian banker heading a Germany-based institution that acts as central bank to a currency from which the UK has distanced itself has lifted our Chancellor off the hook of austerity and possibly saved his reputation. One suspects, however, that this irony will be lost on the eurosceptic wing of his party.

Most of the improved statistics the Chancellor announced today flow from the fact that the economy is getting better. Increased economic activity means higher tax receipts — more income tax, National Insurance, VAT, stamp duty and eventually corporation tax. At the same time, there is less pressure to spend on unemployment and other benefits. Thus we need to borrow less, and the deficit begins to fall. And that is, of course, what he reported.

It is customary, however, to divide the deficit into two parts — the cyclical part, which is expected to disappear with economic recovery, and the structural part, which will allegedly never go away unless we mend our ways and learn to spend less.

It is this structural part — deemed to be excessive spending — that the austerity programme was avowedly designed to attack. But even the Chancellor found it hard to disguise the fact that the structural deficit seems barely to have shrunk. That would seem to imply that the austerity attack has failed — all those cuts have not delivered the structural improvement he promised.

The medicine having failed, his solution is to prescribe still more of it — so he has unveiled £3 billion more of cuts now, and warned of or promised still more cuts in the future. Einstein, one of the great brains of the 20th century, did once say that to repeat an action while expecting a different result was a sign of madness. But Einstein was not a politician.

The Chancellor’s other tactic to distract attention from inconvenient truths is to pull the odd rabbit out of the hat. Hence today’s eye-catching gimmicks, most of which were leaked in advance — the effort to cut £50 off energy bills, the reduction in the expected increase in business rates, the desire to funnel more private-sector saving into lending for small and medium-sized enterprises. All are welcome, and all should make a difference at the margin, but only at the margin because they are pretty small beer in financial terms. For that reason, they are not the criteria by which today’s statement should be judged.

What we really want to know is whether this recovery will last. Clearly, it won’t if it has to continue to depend only on consumers’ willingness to plunge back into debt — whether to buy houses or to splurge on the High Street. But it should if business can be persuaded to invest some of its vast cash pile in building new plant, buying new equipment, launching new products and developing new markets.

The key to bringing business out of its shell is that we continue to show progress without too many signs of skills shortages, pinch points and overheating, which would choke off the expansion before it gets properly growing. Bottlenecks such as a shortage of bricklayers and carpenters could curtail our ability to build more homes, and would prompt employers to offer more money to poach labour from elsewhere. That is how inflation starts. Curbing it would require a rise in interest rates, but then output would collapse and everyone would go back to being thoroughly depressed.

Whether we avoid this as things warm up depends on the size of the output gap — the amount of spare capacity in plant and people that can be called into use as the economy grows without setting off a price rise. Unfortunately, however, the output gap is like the Loch Ness monster — much talked about but never been proved to exist, let alone to be accurately measured for size. So we can talk convincingly about this as the Chancellor did today, but unfortunately it is still guesswork. No one really has any idea how it will pan out.